On Wednesday, Congressional Democrats led by Charles Schumer (D-N.Y.) advocated steering hundreds of millions of dollars into nonprofits to help the growing number of homeowners who are having trouble paying their mortgage. But economists and industry experts say the cost of a bailout would be significantly more than that.
Christopher Cagan, director of research at First American CoreLogic, says rising mortgage payments on adjustable rate loans will force 1.1 million homeowners into foreclosure over the next 6 years. He estimates the cost of paying off the debt for those borrowers would be $120 billion.
Quite frankly, I don't care if the cost of the proposed bail out is $1 or $120 billion, a bail-out of this nature is not only bad economic policy it is also morally bankrupt.
First the moral argument: a government bail-out of the sub-prime market is a form of regressive and oppressive tax. I don't own a home. I am a renter. There are millions of us around the country. Some rent by choice (myself included), but many rent because they cannot afford to buy a house. By bailing out the sub-prime lenders and borrowers, the government would be taking hard earned tax dollars paid by renters, and giving those assets to generally wealthier financial institutions and home owners.
Second, by bailing out sub-prime borrowers the government would be rewarding financial recklessness. For years people have been talking about a real-estate bubble, but sub-prime lenders and borrowers chose not to listen. They chose to try to ride the wave to real-estate riches. If they had succeeded, those of us who chose to remain fiscally prudent and not buy real estate beyond our means, would have gotten nothing. However, now that the reckless real-estate bet failed we must share in the financial burden? Why?
Now for the economic arguments: the government has no business interfering with the free markets unless the markets are inherently incapable of addressing the issue on their own. Predatory monopolists and price fixing are two examples of such market failure where government intervention is needed. In the case of sub prime loans there has been no market failure. Yes, there were a lot of people, both lenders and borrowers, who made horrible financial decisions. However, those decisions are theirs to make and the consequences are theirs to bear.
In fact, if the government decides on some sort of sub-prime bail out, it will be undermining the markets. Healthy markets are built on the idea of risk and return. If a certain asset is risky, fewer investors are willing to invest in it, and therefore the return on that investment goes up. Thus, for sub-prime mortgages lenders demand a higher return in the form of a higher interest rate. Now, assume that the government bails out sub-prime lenders and / or borrowers. Such a move would tell the market that sub-prime loans are far less risky than they previously thought, and so both borrowers and lenders would be more inclined to get into these risky transactions. When investors do not properly understand the risks that they are accepting or think that someone else will bear any negative consequences, they enter into transactions that they would not otherwise pursue. If the government does not let investors and consumers get burned, it is setting us up for the next big financial bubble. Investors will think that the government will be there to bail them out again if the market goes south, thus they will be willing to pay more for risky assets and yet another financial bubble will emerge.
My bottom line: the government should let the sub-prime market fail. They should let the people who knowingly accepted unreasonable risks bear the burden of their mistakes. In the long run, this will only strengthen the markets. For once, Washington should do something it has been doing phenomenally well for many years: NOTHING.